Segmented Trading Markets

Abstract

We study competition among segmented trading venues (fast vs. slow) where traders dynamically choose their venue. Technological improvements in the slower venue raise trading speed, reduce differentiation, and thereby increase trading volume and welfare, while improvements in the faster venue can have an ambiguous effect. Speed enhancements distinctly impact traders based on their sensitivity to execution speed: those with a high willingness to pay or a low willingness to hold benefit most, whereas less speed-sensitive traders face relatively higher transaction fees. Venue choice depends on fees, speeds, and taxes. For example, when the slow venue’s fee rises, traders shift to the fast venue or exit the market depending on their sensitivity to speed. Finally, we show that improving the fast venue’s speed increases total welfare whenever preference shocks occur frequently enough, characterizing when a regulator could design redistributive schemes that leave no stakeholder worse off following a speed improvement. 

Keywords: OTC vs Exchange. Heterogeneous venues. Fragmentation. Competition.

JEL Classification: G12, G2, D4, L13.